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Global stock markets have been highly volatile in August. That has mainly been attributable to the massive market plunges that investors experienced on 2 August (Friday) and Monday (5 August). It wasn’t just the US stock market that saw a steep drop; there were some record declines in Asia as well. The Nikkei Index in Japan saw its worst one-day percentage fall since 1987, falling over 12% in a single day. Many market commentators have blamed what’s called the “Japanese Yen carry trade” for the sudden – and intense – volatility that investors have seen. While stock markets globally have recovered to their previous levels in the past few weeks, investors remain concerned about the potential consequences of any further volatility (related to the Yen carry trade). So, what exactly is the Japanese Yen carry trade and why are investors so worried about it? The yen carry trade is based on a straightforward yet effective financial strategy that exploits the differences in interest rates between countries. At the core of this approach is the ability to borrow in a currency like the Japanese yen, where interest rates are exceptionally low, and invest in higher-yielding assets denominated in a different, stronger currency. For years, Japan has maintained ultra-low, even negative, interest rates to stimulate its economy, keeping borrowing costs in yen close to zero. Investors can easily access capital in Japan at minimal cost by borrowing in yen. They then convert the borrowed amount into a stronger currency, such as the US dollar, which offers significantly higher returns. In 2024, this trade has proven particularly lucrative due to the strength of the US economy and its rising interest rates. As the Federal Reserve raised rates to combat inflation, investments in US financial markets became more attractive. US stocks, particularly those tied to the booming AI industry, such as Nvidia, have performed exceptionally well, reaching new highs. This creates an ideal opportunity for traders who borrowed yen to exchange it for dollars and invest in high-growth US assets. The profitability of the yen carry trade stems from this interest rate differential. Borrowing yen incurs minimal costs, while investments in US assets yield much higher returns, creating a low-risk opportunity to generate significant profits. Additionally, the Japanese yen weakened against the US dollar in 2024 due to Japan’s ongoing dovish monetary policy, further devaluing the yen. This trend enhances the carry trade’s appeal, as traders can maximise their returns by converting yen into dollars before the yen depreciates further. However, the trade is not without risks. Currency fluctuations, such as the Japanese yen strengthening unexpectedly or the US dollar weakening, could result in losses. While the Yen carry trade was clearly popular, as with any popular theme, there always comes a turning point when the trade will (finally) unwind. That point came at the end of July. That was when three big events happened. That was its highest level since 2008 – a significant milestone and a strong sign that the BOJ felt confident enough to keep hiking into the future. In the three weeks running up to the BOJ’s policy decision, the Japanese Yen had strengthened against the US dollar by nearly 10% – an incredibly large move for two influential currency pairings. The USD/JPY was trading at 161.61 (1 USD = 161.61 Yen) on 10 July. On 31 July, it was trading at 149.75. As of 21 August, it’s at 145.63.  the Fed was going to shift towards a more balanced focus on maintaining a healthy labour market while also bringing inflation down towards its target of 2%. Previously, the Fed’s main focus was on taming inflation. However, with these comments, the market was more confident that weakening jobs data would result in the US central bank cutting interest rates at its next FOMC meeting in September.  while the unemployment rate moved up to 4.3%, its highest level since October 2021. The data release suddenly caused investors to believe that the US economy may be headed for a recession in the near future. As a result, there were suddenly higher expectations for deeper interest rate cuts by the US Fed. Combined, all this resulted in a massive unwinding of the Yen carry trade, where everyone rushed for the exit door at the same time. Given the converging monetary policy stances and data points between a hawkish BOJ and an increasingly dovish Fed, that started on Friday (2 August) and continued into the following week. Recent robust US economic data, including a low Consumer Price Index (CPI) reading and robust retail sales, suggests that the Federal Reserve may not cut interest rates as much as previously expected. Adding to the uncertainty are expectations that Bank of Japan Governor Kazuo Ueda might adopt a dovish tone in his appearance today before Japan’s parliament on Friday, 23 August. Happening today as well, traders will closely watch Federal Reserve Chairman Jerome Powell’s speech at the Jackson Hole symposium for indications of the Fed’s future interest rate policy. These factors combined could lead to increased volatility for global investors, as the Japanese Yen carry trade continues to pose potential disruptions—something investors will be monitoring closely. Receive a Welcome Rebate of up to $150 when you trade with IG. Simply your account, and trade CFDs during your Welcome Period.* *T&Cs apply. CFD Losses can exceed deposits. 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